Where's Why U.S. Concrete's Over-Levered Roll-Up Is Struggling And Why Earnings Appear Overstated Due To Overcapitaliztion Of Expenses: 60% To 90% Downside Risk

May 17, 2018 9:47 AM ET

Summary

U.S. Concrete exhibits many of the characteristics of Spruce Point's most successful shorts (Caesarstone and China Integrated Energy) - stable margins in a commodity industry and abnormal capex forecasting.

Significant divergence between Non-GAAP results and cash flow signals strain from the poor economics of its roll-up strategy. Leverage is now at pre-financial crisis highs, while liquidty is at lows.

We estimate $60 to $85m of costs have been aggressively capitalized in USCR's mixer truck and vehicle account along with abnormal capital lease usage inflating Adjusted EBITDA and cash flow.

USCR has churned through three auditors and four CFOs since 2012. We found the CFO plead guilty to a DWI, though it has been undisclosed. All insiders including the CEO have been heavy sellers.

USCR's offers no guidance, and sell-side analysts have done a horrible job estimating results, yet still see 40% upside on out-sized growth. We disagree and normalize results for overcapitalization to estimate 60% to 90% downside risk.

Report Entitled "Concrete Evidence of Financial Scheming"

Executive Summary

Spruce Point Capital Management is pleased to announce it has released the contents of a unique research report on U.S. Concrete, Inc. (Nasdaq: USCR) ("USCR" or "the Company").

Spruce Point has conducted a critical forensic and fundamental analysis of the Company, a roll-up of commodity ready mix concrete businesses, that is showing severe signs of cracking. Our report will detail why we believe USCR exhibits many identical characteristics to Caesarstone and China Integrated Energy, two of our most successful short calls where we identified abnormally stable gross margins, and unusual capital expenditures, which are inconsistent with commodity product businesses.

As a result of our investigative analysis, we have issued a "Strong Sell" opinion, and a long-term price target of approximately $7.00 to $23.00 per share, or approximately 60% - 90% long-term downside risk.

Our detailed research report is available on our website. We also encourage all of our readers to follow us on Twitter @sprucepointcap for regular updates. Please review our disclaimer at the bottom of this email.

Some of the key highlights include:

Previous Failure: USCR filed for bankruptcy after the financial crisis. The industry is difficult given the commodity nature of the products, intense competition, and need to be in close proximity to the customer due to material shipping costs

Deja Vu Leverage Rising Again: USCR’s Net Debt / EBITDA was 3.5x prior to the financial crisis sending it to bankruptcy, and is now 3.8x as of 3/31/18. USCR’s current liquidity (cash and borrow capacity) as a percentage of LTM revenues stands at a multi-year low and worse than pre-crisis levels

Becoming More Dependent on Shady Acquisitions: USCR has acquired over 20 companies since 2012. It recently outbid industrial giant Vulcan Materials for Canadian small cap Polaris Materials and purchased firms with alleged historical ties to organized crime

GAAP vs. Non-GAAP Strains and Cash Flow Issues Becoming Evident: In 2017 there were a record number of adjustments to results, and yet Adjusted EPS grew by just 4%. Despite promoting sales and Adj. EBITDA growth of ~20% in the past three years, operating cash flow has been declining for more than 3 years in a row. Recent guidance of 60% cash flow conversion from Adj. EBITDA has been terribly missed

Stable Gross Margins In A Commodity Business: Despite cash flow issues, USCR has reported stable gross margins at 21% for three years, which is a remarkable feat given it operates in a commodity business, and we find peers reporting between 9% - 12% margins over the same period

USCR Claims Mid To High Single Digit Organic Growth: Evidence suggests organic growth is overstated, and mostly a function of pass through commodity price increases. We note realized prices by USCR hit a 5yr low in 2017, and have continued lower in Q1’18. We find average organic volume growth from 2015-2017 to be approximately zero

Vehicle and Truck Property Accounts Suggest Overcapitalization: Since 2012, USCR financials show ~500% growth in the vehicle property account, yet physical trucks are up only ~100%. USCR claims truck prices are stable, and we believe many have been acquired used through acquisitions, so overcapitalization of costs is a likely explanation. We estimate $60 to $85m of excess costs are capitalized in the vehicle accounts

CEO Concerns and Rapid CFO and Auditor Turnover: A routine background check of the CEO reveals an undisclosed DWI arrest for reckless driving, calling into question his judgement. USCR is on its fourth CFO since 2012. Recent CFO John Tusa, Jr. resigned after serving a little more than one year. USCR is on its third auditor since 2012, and its current lead audit engagement partner just had an administrative consent order filed in Oklahoma for not being current in his professional education requirements

USCR Trading Near All-Time Cyclical High Valuation: USCR is valued at approximately 1.2x, 8.0x, and 15x 2018E Sales, Adj EBITDA and Adj. EPS. On the surface, shares “appear” cheap, but the company offers no firm guidance, and analysts have been quietly and slowly cutting forward estimates. We have little faith in management’s reporting given our documented concerns. Spruce Point also never recommends buying into a commodity company near the peak of a leverage cycle: this is a recipe for disaster!

Two Ways To Value USCR Point To 60% - 90% Downside Risk: Given our analysis that shows distortions in USCR’s Non-GAAP figures, we believe the best way to value the Company is on Free Cash Flow. We expect further deterioration which began three years ago, and apply a 20x – 25x multiple to reflect a discount to the peer average, above average exposure to ready-mix, poor roll-up economics, and growing liquidity risk. Secondly, we adjust USCR’s book value for an estimated $60 - $85 million of overcapitalized costs to its vehicle property accounts and apply a 1.0x – 1.5x multiple range. These valuation perspectives indicate 60% to 90% downside or approximately $6.00 to $25.00 per share

Thank you very much for your continued interest in our investment research.

Disclaimer

This research presentation expresses our research opinions. You should assume that as of the publication date of any presentation, report or letter, Spruce Point Capital Management LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our subscribers and clients has a short position in all stocks (and are long/short combinations of puts and calls on the stock) covered herein, including without limitation U.S. Concrete, Inc. (“USCR”), and therefore stand to realize significant gains in the event that the price of its stock declines. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation. All expressions of opinion are subject to change without notice, and Spruce Point Capital Management does not undertake to update this report or any information contained herein. Spruce Point Capital Management, subscribers and/or consultants shall have no obligation to inform any investor or viewer of this report about their historical, current, and future trading activities.

This research presentation expresses our research opinions, which we have based upon interpretation of certain facts and observations, all of which are based upon publicly available information, and all of which are set out in this research presentation. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward looking statements, expectations, pro forma analyses, estimates, and projections. You should assume these types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond Spruce Point Capital Management LLC’s control. This is not investment or accounting advice nor should it be construed as such. Use of Spruce Point Capital Management LLC’s research is at your own risk. You should do your own research and due diligence, with assistance from professional financial, legal and tax experts, before making any investment decision with respect to securities covered herein. All figures assumed to be in US Dollars, unless specified otherwise.

To the best of our ability and belief, as of the date hereof, all information contained herein is accurate and reliable and does not omit to state material facts necessary to make the statements herein not misleading, and all information has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer, or to any other person or entity that was breached by the transmission of information to Spruce Point Capital Management LLC. However, Spruce Point Capital Management LLC recognizes that there may be non-public information in the possession of USCR or other insiders of USCR that has not been publicly disclosed by USCR. Therefore, such information contained herein is presented “as is,” without warranty of any kind – whether express or implied. Spruce Point Capital Management LLC makes no other representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use.

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